Finance and Economic

One of the most controversial provisions in President Obama’s proposed budget might have a short shelf life on Capitol Hill.

To pay for half of his $634 billion health reform fund, Obama has proposed limiting deductions for high-income taxpayers starting in 2011.

Instead of using their top income tax rate to calculate the value of a deduction, single filers making more than $200,000 and joint filers making more than $250,000 wouldn’t be allowed to reduce their bill by any more than 28% of a given deduction. That’s below what the top two tax rates would be in 2011.

That means the value of some of the most popular deductions — such as mortgage interest and charitable contributions — would be reduced for high-income filers.

But the provision, which is likely to be debated at a health care summit the president has set for Thursday, has already met resistance from some leading Senate Democrats including Finance Chairman Max Baucus and committee member Ron Wyden, D-Ore.

At a hearing Wednesday, Baucus told Treasury Secretary Tim Geithner that he questioned the "viability" of the itemized deduction proposal and suggested the administration find another way to help pay for its health reform fund.

"There are other tax provisions that have a lot to do with health care, but that one does not. I’d just urge the administration to dig down deeper to try to find viable savings and concentrate on savings within health care reform," Baucus said.

One main criticism of Obama’s proposal is that it would harm charitable giving.

In response, Geithner said the provision would only affect 1.2% of taxpayers and have only "modest effects" on how much people donate.

"The most important thing you can do for overall charitable giving is to get the economy strong," Geithner said.

One expert agrees that giving is closely tied to the fate of the economy.

"If GDP is down, there’s going to be a decline in giving," said Daniel Borochoff, president of the American Institute of Philanthropy.

Len Burman, director of the Tax Policy Center, estimates that the provision would reduce annual giving by roughly 2%, or $9 billion, in 2011 totally free credit score.

Congressional push-back on the plan to curb deductions could force the administration to find another way to generate the billions it needs to fund its signature health care plan.

Senator offers another approach

Baucus pointed to one possible alternative. He asked Geithner whether the administration would consider generating new revenue by curbing or eliminating the tax break offered to employees when they buy health insurance policies through their companies.

Currently, the portion of their premiums paid by the employer is treated as tax free income to employees, meaning they pay no income tax on that subsidy, nor do they pay Social Security or Medicare tax on it.

The health insurance exclusion is the federal government’s single biggest tax expenditure, worth $246 billion in forgone revenue in 2007, according to the Joint Committee on Taxation.

Calls to change the tax exclusion have been made before both because the subsidy does not discourage workers from being more cost-conscious in their health care decisions and because it favors only those who get insurance through an employer, not those who buy policies on their own.

During last year’s campaign, Obama said that while he wanted to reform health care, he would not seek to overturn the tax-free subsidy for those who get their insurance from their jobs.

Without committing to Baucus’ suggestion in particular, Geithner seemed to indicate that the administration might be willing to reconsider its deduction proposal.

"We recognize there [are] more paths to [paying for health reform] than what we laid out in the budget," he told the Finance Committee. "But we wanted to put it on the table to prove the credibility of our commitment to do this, concrete proposals that would achieve that."  

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Companies cut 697,000 jobs in the U.S. in February as the recession’s grip tightened, offering no sign the pace of the decline in payrolls is easing.

The drop in the ADP Employer Services gauge, a survey based on payroll data, was larger than economists forecast and followed a revised cut of 614,000 for the prior month.

Employers are cutting staff as demand plummets in the face of strained credit and battered housing and equity markets. The Labor Department may report in two days that employers cut payrolls in February for a 14th consecutive month, putting jobs losses in the current downturn at more than 4.2 million, according to a Bloomberg survey.

“We doubt any of these numbers have hit bottom yet,” Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd. in Valhalla, New York, said in a note to clients. “Employment is tanking right across the economy.”

The ADP report was forecast to show a decline of 630,000, according to the median estimate of 26 economists in a Bloomberg News survey. Projections ranged from decreases of 500,000 to 770,000.

ADP revised its methodology late last year in a bid to limit differences between its calculations and the government’s payrolls numbers.

The ADP figures include only private employment and do not take into account hiring by government agencies. Macroeconomic Advisers LLC in St. Louis produces the report jointly with ADP.

Announcements Surge

Job cuts announced by U.S. employers more than doubled in February from a year earlier, led by planned cutbacks at retailers and automotive companies, Chicago-based placement firm Challenger, Gray & Christmas Inc. said today.

Firing announcements rose 158 percent last month from February 2008, to 186,350 car loans. The monthly total fell 23 percent from January’s seven-year high of 241,749 following the worst holiday retail sales season in four decades, Challenger said.

Today’s ADP report showed a reduction of 338,000 workers in goods-producing industries including manufacturers and construction companies. Employment in manufacturing dropped by 219,000. Service providers cut 359,000 workers.

Companies employing more than 499 people shrank their workforces by 121,000 jobs. Medium-sized businesses, with 50 to 499 employees, cut 314,000 jobs and small companies decreased payrolls by 262,000.

GM Crisis

General Motors Corp. was among companies cutting staff. On Feb. 18 the Detroit-based automaker said it planned to cut an additional 47,000 workers worldwide and needed an additional $16.6 billion in new federal loans to keep operating while it restructures its operations to avoid bankruptcy.

Caterpillar Inc., the world’s largest maker of earth-moving machinery, said Feb. 11 it was offering a voluntary retirement package to about 2,000 U.S. production employees, in addition to more than 22,100 announced dismissals.

“Depending on business conditions, more voluntary and involuntary workforce reductions may be required as the year unfolds,” the Peoria, Illinois-based company said in a statement.

The ADP report is based on data from 400,000 businesses with about 24 million workers on payrolls.

ADP began keeping records in January 2001 and started publishing its numbers in 2006.

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American International Group Inc, whose $61.66 billion quarterly loss was the largest ever for a U.S. company, has been sued for securities fraud by former Chief Executive Maurice "Hank" Greenberg.

Greenberg, the insurer’s largest individual shareholder, accused AIG of overstating its financial health and masking losses on credit default swaps that hedged default risk for at least $527 billion of debt.

He said AIG’s (AIG, Fortune 500) "material misrepresentations and omissions" had caused him to acquire shares as part of various deferred compensation plans at an inflated price, and later to lose nearly his entire investment after AIG’s losses became known.

AIG shares closed at $54.37 on Jan. 30, 2008, the date that Greenberg said he acquired AIG shares through the deferred compensation plans.

The shares closed Monday at 42 cents after news of the fourth-quarter loss and yet another government rescue deal.

Greenberg is seeking the difference between what he paid for the shares and what he said the shares were worth, as well as reimbursement of more than $70 million of taxes.

The lawsuit also named several individuals as defendants, including Greenberg’s successor Martin Sullivan and Joseph Cassano, the former chief of AIG’s financial products unit, which originated many of the credit default swaps auto loan.

AIG spokeswoman Christina Pretto said the lawsuit was without merit, and that the insurer would defend itself vigorously. Sullivan and Cassano did not immediately return calls to their homes seeking comment.

Greenberg ran AIG for nearly four decades before being ousted in March 2005, when New York Attorney General Eliot Spitzer was investigating transactions involving the insurer.

AIG’s quarterly loss led to a loss of $99.29 billion for the year, largely stemming from writedowns related to credit default swaps, mortgage securities and other toxic debt.

The problems resulted in a new government bailout for AIG, which will get access to as much as $30 billion of new capital. The government had already given AIG $150 billion as part of a rescue last year, and took a nearly 80 percent equity stake. 

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Although consumer confidence is down nationwide, a new survey of small-business owners finds that 87 percent don’t regret their decision to go into business for themselves and would do it over again if they had to.

The survey by PayCycle, an online payroll service, found just 10 percent were unsure if they would start a business again, and 3 percent said they would not.

More than two-thirds said they started their own business because they wanted the freedom to work for themselves. Six percent said they started their businesses because they had been laid off, while 5 percent were continuing a family business. Twenty-two percent cited a variety of other reasons, including wanting to be more available to family, the desire to work with a nonprofit and running a side business to supplement income easy online payday loans.

Among the challenges facing small-business owners:

• Twenty-nine percent cited finding good employees.
• Twenty-six percent cited dealing with legal and accounting issues.
• Twenty-one percent cited finding customers.
• Sixteen percent cited finding funding as the biggest challenge faced when starting their businesses.

The survey, conducted between Jan. 27 and Feb. 2, was compiled from responses by 478 small businesses randomly selected from PayCycle’s more than 75,000 small-business customers.

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The stock market slumped to a 12-year low last week, partly over fear of a single word: nationalization.

It’s a word Americans are used to hearing from South American republics. Now, it’s being mentioned — prominently — as a potential fate for some of America’s largest banks.

Over the past two weeks, free-market conservatives such as former Federal Reserve Chairman Alan Greenspan and Sen. Lindsey Graham, R-S.C., have said some giant banks may have to be nationalized temporarily.

The nation’s second-biggest bank, Citigroup, negotiated its own partial nationalization last week. The deal would convert up to $25 billion of the government’s $45 billion capital stake in the bank from preferred stock to common stock.
The U.S. Treasury would have up to a 36 percent of the equity voting power at troubled Citigroup. The government’s new clout in bank management showed in Citigroup’s decision to reform its board, putting independent directors in a majority.

For the record, both the administration of President Barack Obama and the Federal Reserve indicate that they don’t want to nationalize banks. The question concerns whether they will have much choice.

Citigroup lost $27 billion last year, threatening its survival without a government bailout.

Other giant banks may be headed in the same direction as the economy sinks.

The FDIC reported last week that America’s banks lost $26 billion in the last quarter of 2008, the biggest banking bust since 1990. More than two-thirds of banks made money, but profits at small and mid-sized banks were outweighed by massive losses at big banks.

"They’ll do this kind of deal with other companies," said Joe Stieven of Stieven Capital Advisors, a longtime St. Louis bank analyst. "I think this is good for the U.S., but in the short term it could be bad for common shareholders."

Other analysts see Bank of America as the next most likely to need a government investment as it struggles with bad loans and the consequences of acquiring big, sick companies.

"Bank of America was a rock of strength until it took on Countrywide Mortgage and Merrill Lynch," said Stuart Greenbaum, former dean and professor emeritus at Washington University’s business school.

LOCAL IMPACT

The issue could have an impact on St. Louis. Citigroup has no branches here, but it owns CitiMortgage, which employs about 3,500 people in O’Fallon. Many St. Louisans also have mortgages, credit cards or loans through the bank.

Bank of America has 61 branches in our region and is a major lender here. It holds 14 percent of the St. Louis area’s deposits, a market share second only to U.S. Bank.

Other big players in the St. Louis market will be subject to the government’s new "stress test," in which it will judge large banks’ ability to survive a deeper recession. They include U.S. Bank, PNC Financial (purchaser of ailing National City Bank) and Regions Bank.

All are headquartered elsewhere but have branch networks in St. Louis. Together, they and Bank of America hold 40 percent of the St. Louis deposit market.

Nationalization means government control of failing companies. That’s already happened in the case of insurer AIG and mortgage giants Fannie Mae and Freddie Mac. In the case of banks, nationalization would take place as the government injected capital into the banks in exchange for stock, until the government owned a controlling interest.

In theory, the government would recapitalize the banks, then sell its shares back to private ownership as the economy recovered. If things go well, the government might recover its money or even make a profit.

Stieven thinks the Citigroup deal is structured well, because it allows the government to force changes at the company while leaving management in private hands.

But some wonder what might happen as time goes on: Would Uncle Sam change lending policies? Will pressure from Congress influence who gets loans?

"A money-center bank in government hands would become a conduit for politicized lending and grants disguised as loans," wrote Gerald O’Driscoll, a fellow at the libertarian Cato Institute and a former vice president at the Federal Reserve Bank of Dallas.

Greenbaum thinks the government may use its newfound control for another goal: breaking up the biggest financial institutions personal loans for bad credit. The biggest have strayed far beyond the business of lending money and now have fingers in financial markets around the globe. They are now so complex that their own managers can’t comprehend them, he says.

"If a bank is too big to fail, maybe it’s too big to succeed," he says.

FDIC TAKEOVERS

In one way, bank nationalization is nothing new. The FDIC has been doing it every Friday as it seizes banks that are insolvent or nearly so. It pays off the depositors, in part with federal money, and sells the branches. Shareholders are wiped out.

It did just that last month with Corn Belt Bank of Pittsfield, Ill. The FDIC took over on a Friday, and the branches reopened four days later as part of Carlinville National Bank.

In fact, the FDIC prefers to act before banks go broke, by forcing the weaklings into the arms of healthy banks. PNC’s takeover of ailing National City last October was such a shotgun marriage.

Economists say those actions have a big advantage: They’re a clean break. The losses are written off, and the surviving banks go on lending.

In the savings and loan crisis of the late 1980s, the government seized hundreds of failed S&Ls, placed their assets in a government corporation and sold them off over time. The cost of those seizures, which didn’t threaten the country’s banking system, cost taxpayers more than $120 billion.

The problem comes with banks that are too big to sell, and too big to fail.

Giants such as Citigroup, with more than $2 trillion in assets, are deeply entwined in a web of interlocking obligations to institutions around the world. Citigroup’s failure could set off a financial panic that might bring even healthy banks to their knees.

If giant banks can’t fail, then what’s to be done with them when they go insolvent? One danger is that they continue as "zombies," the living dead of the financial system.

Even insolvent banks can stagger on for long periods. They’re too sick to lend, but they suck consumer deposits away from healthier banks that would actually use the money to make loans.

"The very existence of large zombie banks would make it more difficult to restart the flow of credit," wrote Douglas Elliott of the Brookings Institution, a Washington think tank.

Economists blame Japan’s "lost decade" of the 1990s partly on the government’s reluctance to fix failing banks.

That brings up the Swedish solution. When Swedish banks began failing in the 1990s, the government took them over and recapitalized them. Then the Swedes sold them back to the private sector.

Obama’s plan, announced last week, would put the biggest banks through stress tests to see how they would cope in a deeper recession. Those deemed weak would be given a chance to raise private capital. If they can’t, the government would step in as the banks weakened, providing capital in exchange for an ownership stake.

The root of the banking crisis lies in the pile of "toxic assets," mainly mortgage securities, weighing down bank balance sheets. If big banks could unload them at reasonable prices, they’d be on the road to recovery.

But no one wants to buy, so it’s hard to put a price on them. And the government is hesitant to become the buyer of last resort: If it paid too much, it would stick the taxpayers with huge losses. If it paid too little, banks would still be weak.

Obama’s solution is to seed a private fund with government capital, hoping to tempt private investors. The fund would then buy toxic assets, with the private investors negotiating the price.

Will the Obama plan work? "It’s a reasonable alternative right now," says Anne Villamil, a professor of economics at the University of Illinois, adding that we’d never been in a mess such as this before.

Greenbaum is more blunt. "It’s a piece of arrogance to think we really know what we’re doing," he said.

jgallagher@post-dispatch.com | 314-340-8390

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The government’s closely watched list of troubled banks grew during the fourth quarter to its highest level since 1994, regulators said Thursday.

The Federal Deposit Insurance Corp. reported that the number of firms on its so-called "problem bank" list grew to 252 during the last three months of 2008, compared with 171 banks making the list in the prior quarter.

"There is no question that this is one of the most difficult periods we have encountered during the FDIC’s 75 years of operation," agency Chairman Sheila Bair said Thursday.

Problem banks typically face difficulties with their finances, or are suffering through operations or management issues that pose a threat to their existence.

The institutions that wind up on the list are considered the most likely to fail, although few of them actually reach that point. On average, just 13% of banks on the FDIC’s problem list have failed.

The FDIC - one of the top regulators of the nation’s banking system - doesn’t reveal the names of the banks on the list, but it does give the total assets of these institutions.

That number topped $159 billion during the most recent quarter, up from $116 billion the previous quarter.

As the U.S. economy has deteriorated, the pace of bank failures has quickened in recent months as banks struggle under the weight of rising loan losses.

Fourteen banks have failed so far this year, including last week’s collapse of Silver Falls Bank, a relatively tiny Oregon-based institution located about an hour south of Portland.

Still, the current crop of bank failures hardly comes close to what happened during the savings & loan crisis two decades ago. More than 1,900 financial institutions went under during 1987-1991, peaking with the failure of 534 banks in 1989.

In the event of a failure, the FDIC fully insures individual accounts up to $250,000 for single accounts.

Record losses for the industry

Overall, the fourth quarter proved to be an incredibly difficult period for the more than 8,300 banks that make up the nation’s banking industry payday loan online.

During the period, the group posted a net loss of $26.2 billion, representing its largest quarterly hit in the 25 years that insured institutions have reported quarterly results.

Regulators blamed a combination of factors for the quarter including losses from trading activity, massive writedowns taken by banks as well as rising loan losses.

To cope with the deteriorating economic environment, banks set aside a whopping $69.3 billion in funds for future loan losses - more than double year-ago levels.

"The trend is clear - troubled loans are rising and will continue to rise in the near future," said Bair.

The latest assessment of the health of the nation’s banking sector comes just a day after industry regulators unveiled plans to "stress test" the nation’s 19 largest banks in order to gauge the size and scope of any future government aid.

Sor far, the Treasury Department has extended nearly $200 billion in aid to banks, with the bulk of that aid going to some of the nation’s biggest lenders including Citigroup (C, Fortune 500), Bank of America (BAC, Fortune 500) as well as Wells Fargo (WFC, Fortune 500) and JPMorgan Chase (JPM, Fortune 500).

FDIC’s Bair threw her support behind the open-bank assistance efforts taken so far, noting that her agency would face limitations if it attempted to place a leading bank into receivership.

Such actions would not only fall somewhat outside the agency’s authority, but she also noted that the FDIC could face a "resource issue" if it attempted to undertake such a task. 

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